Canada first in G7 to raise interest rates, hikes policy rate to 0.5 per cent

The Canadian Press ~ The News
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Borrowing costs for consumers and businesses are slated to start rising moderately after the Bank of Canada moved off its ultra-stimulative monetary policy Tuesday, hiking its trendsetting interest rate a quarter point.
It was the first time in almost three years that the central bank actually raised the policy rate but it will still be regarded as a bold and perhaps risky move on the part of governor Mark Carney.
The move lifts the trendsetting overnight rate to 0.5 per cent and puts Canada first among the world's G7 leading economies to start tightening monetary policy - and it may remain out on a limb for some time.
Most analysts don't expect any others among the big seven to start raising interest rates until next year at the earliest.
The initial reaction of markets was to take the Canadian dollar down almost a cent to 94.93 cents US, although the loonie recovered most of the losses by mid-morning.
Scotiabank economist Derek Holt said the market reaction was in line with expectations that Carney would be more "hawkish" in his statement. Instead, the bank statement seemed to cast doubt whether it would continue to raise rates or take a pause.
"Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments," the bank said.
Markets had already largely priced in a quarter-point hike and most analysts had forecast Carney would keep making incremental increases for the rest of the year.
"They can have their cake and eat it too by signalling they are serious about reinforcing price stability, but they are not going to go too far out on a limb," said Holt.
The decision will likely affect financial vehicles such as variable rate mortgages and lines of credit tied to the prime rate.
But Holt said a quarter-point hike is so small that it will have little impact on borrowing behaviour. Canadians can mitigate the higher interest rate by stretching out amortization schedules, or by paying down less principal, he explained.
The Bank of Canada also stressed that real interest rates in Canada remain exceptionally low.
"This decision still leaves considerable monetary stimulus in place," it wrote in an accompanying note.
Carney's action would not have raised eyebrows a few weeks ago, when an entrenched global recovery appeared on solid ground. But since then Europe's unfolding debt crisis and bank weaknesses in Spain have shaken the foundations of the global outlook.
Still, Canada's central bank said conditions had improved sufficiently to move off what had been described as the emergency rate for the economy of 0.25 per cent, where it had been since April 2009.
The bank said Canada's economic growth has been unfolding largely as expected, citing Monday's release by Statistics Canada that showed gross domestic product output had expanded by 6.1 per cent in the first quarter.
It said that household spending is expected to moderate, while business investment fills in the gap.
The darkening clouds on the horizon all have to do with the global economy, which the bank said remains heavily dependent on low interest rates and government spending and is becoming "increasingly uneven."
There is strong growth in emerging economies like China and India, some consolidation in the United States and Japan and "tensions" in Europe that are likely to result in higher borrowing costs and a ratcheting down of government spending that will slow growth.
"Thus far, the spillover into Canada from events in Europe has been limited to a modest fall in commodity prices and some tightening in financial conditions," the bank said.
But it noted that Europe remains an important downside risk for the global economy, which would likely have spillover effects for Canada.
In raising the overnight target rate, the central bank noted that it is keeping the deposit rate it pays out to financial institutions for holding short-term deposits at one-quarter point, re-establishing the normal operating band of 50 basis points.

Organizations: Bank of Canada, Scotiabank, Statistics Canada

Geographic location: Canada, United States, Europe Spain China India Japan

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Recent comments

  • John
    July 02, 2010 - 13:08

    We had to be the first out of the gate! Hope we can maintain the pace. The economic recovery won't be forced, it will take time to heal and for the economy to stabilize. If we force the issue we may risk aggravating old injuries or opening new wounds. Things are getting better, but we have to take it slow, keep rates low!

  • John
    July 01, 2010 - 19:43

    We had to be the first out of the gate! Hope we can maintain the pace. The economic recovery won't be forced, it will take time to heal and for the economy to stabilize. If we force the issue we may risk aggravating old injuries or opening new wounds. Things are getting better, but we have to take it slow, keep rates low!